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SEC Approves Facebook IPO Settlement

Nasdaq to pay brokers $62 mln for its mishandling of the public offering.

Regulators cleared Nasdaq OMX Group Inc.’s plan to pay $62 million to compensate brokers for its mishandling of Facebook Inc.’s public debut, dealing a defeat to Wall Street firms that say they lost many times that amount.

The Securities and Exchange Commission approved Nasdaq’s request to change its rules and expand the compensation pool for member firms in the May 18 initial public offering. The funds will go to traders who lost money after a design flaw in the exchange’s computers delayed Facebook’s open and left traders confused about how many shares they owned.

Nasdaq’s proposal was opposed by Citigroup Inc. and UBS AG, which said in letters urging the SEC to reject it that losses within their market-making units exceeded $62 million. Nasdaq, balancing its role as an organization with legal immunity for technology breakdowns with its obligations to members, said the pool covers “objective, discernible” losses suffered by brokers.

While agreeing the proposal won’t compensate all purported losses, the SEC said it provides “significantly more compensation for eligible claims, outside of litigation, than would otherwise be available,” according to its order. “Accordingly, approval of the proposed rule change will make more funds available to compensate investors and Nasdaq members under Nasdaq rules, which the commission believes is in the public interest,” it wrote.

Scott Helfman, a spokesman for Citigroup, declined to comment on the settlement. Megan Stinson, a New York-based spokeswoman for UBS, did not immediately respond to a request for comment.

Under existing rules, Nasdaq’s liability for losses related to computer malfunctions is $3 million, and may have been as low as $500,000 in the Facebook case, the SEC said in its order.

“We’re pleased that the Securities and Exchange Commission has approved our accommodation plan, which will enable our customers and members and market participants to receive appropriate restitution as FINRA promptly begins processing claims,” Joseph Christinat, a spokesman for Nasdaq OMX, said by phone today.

The pricing of the first public transaction on May 18, a trade known as the IPO cross, took a half hour longer than Nasdaq planned because of technical malfunctions. In May, Nasdaq OMX Chief Executive Officer Robert Greifeld acknowledged “poor design” in software put the opening auction into a loop that delayed its completion.

Nasdaq’s handling of the Facebook IPO may still end up in court. In approving the rule change needed to accommodate the payouts, the SEC said the question of whether Nasdaq is entitled to regulatory immunity in its handling of the offering is outside the scope of the decision. Nasdaq has made releasing it from legal liability a condition for receiving compensation.

That immunity argument was raised in a letter sent to the commission in August by Citigroup. Decisions made by the second-largest U.S. equity trading venue in the IPO were aimed at protecting profits rather than member firms, the company said.

“Market participants suffered hundreds of millions of dollars of losses as a result of Nasdaq’s profit-driven conduct prior to and during the Facebook IPO, not as a result of protected regulatory activity by Nasdaq, or routine system failures,” Citigroup wrote in August. “Nasdaq should not be permitted to hide behind regulatory immunity.”

‘Unprecedented Failures’

The proposed plan is “inadequate to address the magnitude of Nasdaq’s unprecedented failures,” UBS told the SEC in a letter on Aug. 22. The bank entered multiple orders for Facebook shares because it didn’t receive confirmations, leading to losses of more than $350 million, UBS said. It asked the SEC to work with Nasdaq to reformulate the proposal to increase the amount paid and cover a broader range of trading losses.

Citigroup, Chicago-based Citadel, UBS in Zurich and Knight Capital Group Inc. in Jersey City, New Jersey, operate equity wholesaling groups, brokers that execute orders for individual investors sent by securities firms such as Charles Schwab Corp., TD Ameritrade Holding Corp. and Fidelity Investments. Combined, the firms claim they lost almost $500 million in the offering.

Citadel and Knight previously said they supported Nasdaq’s repayment proposal.

The SEC confined its decision to issues of exchange rulemaking and said Nasdaq’s proposal was consistent with laws that require regulations to prevent fraud, remove impediments to a free and open market, protect investors and the public interest, and deter discrimination among customers, issuers, brokers and dealers.

“Commenters have raised a number of concerns about the proposed rule change, many contending that it is not a fair or equitable approach to compensating market participants,” the SEC wrote in its order. “Nasdaq has explained, however, that it did not design the proposed rule change to compensate all claims of loss suffered by market participants,” it said.

“Rather, Nasdaq, in the accommodation proposal, is proposing to change a Nasdaq rule that in its current form strictly limits the amount of compensation that may be paid to users of the Nasdaq Market Center,” it wrote. “In considering whether to approve the proposed rule change, the commission takes into account the existing circumstances and the manner in which the Nasdaq rule would operate if the commission disapproved the proposed rule change.”

Delays and malfunctions on the Nasdaq Stock Market were the first signs of trouble in the Facebook IPO that burned investors and prompted lawsuits against the company, its exchange and the underwriters. The stock has fallen more than 30 percent from the price set by underwriters. It slipped 0.9 percent to $25.51 as of 10:18 a.m. in New York.

Facebook was sold by underwriters at $38 on May 17. The pricing of the first public transaction, a trade known as the IPO cross, took place at 11:30 a.m. New York time the next morning, a half hour later than Nasdaq planned. About 30 minutes after that, the market owner reported a delay confirming trades from the opening auction with the brokers that placed orders.

The transaction reports, normally distributed immediately, were sent at 1:50 p.m., leaving market makers, brokers and their customers uncertain about whether orders submitted into Nasdaq’s opening cross had been executed. Traders and individuals couldn’t sell to limit losses until they received the reports and knew how many shares they held.

The payout proposal covered what’s “directly attributable to the system issues experienced by Nasdaq,” the exchange operator told the SEC in a Dec. 7 letter.

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